Friday, October 4, 2013

Bad news and the October outlook

In
recent commentaries we’ve discussed the likelihood of a broad market correction
due to a series of divergences among the major averages. The divergence between the Dow and the
NASDAQ, for instance, suggests insider distribution. Not surprisingly, insider transactions show
that corporate insiders have done more selling of their company’s stock than at
any time in several months.

Uncertainty
in Washington has also weighed heavily on stocks as investors ponder what
effect a continued U.S. government shutdown could have on the economy. Broad market volatility continued to expand
as the Volatility Index (VIX) is up 20% this week after closing at a new
3-month high (below). As long as VIX is
in this position the stock market will be quite vulnerable to negative news
headlines.

Speaking
of headlines, in the weeks leading up to the market pullback the news headlines
c magazine covers were anything but negative.
Optimism bordering on euphoria was reflected on the front covers of
several major financial magazines, including Barron’s, Time and Businessweek.

The
Sept. 23 issue of Time magazine, for
instance, featured another one of those infamous bull market covers. The bull was displayed rather prominently on
the cover under the headline, “How Wall Street Won.” Paul Macrae Montgomery, a pioneer of the
magazine cover indicator, told Barron’s last month that the Time cover suggested “an 80% chance the
market will top in a month and will be lower a year from now.”

The
following week Time featured a story
with the headline, “Can Google Solve Death?” on its front cover. Google represents one of America’s biggest
corporate monoliths, and an article suggesting that even death itself could be
conquered by the juggernaut is indicative of excess optimism which is normally
seen at market tops. The cover graphic
on a recent issue of The Week
suggests complacency about the outsized role of Wall Street in the U.S. economy
and was also suggestive of a top.

The
combined picture presented by these covers is one of investor exuberance – a
potentially dangerous state of mind entering a month that historically has seen
more than its fair share of volatility.
Until we see a return of healthy levels of fear in the headlines and
sentiment indicators, investors might consider scaling back on purchases and
watching key support levels for potential breaks in October.